Forex Smart Tools Newsletter ~ Volume Two
When I was in seventh grade, I had a grammar teacher who loved vocabulary. She always got a laugh out of us when she put these two words together, because they are such a mouthful to say. Eschew means to avoid using. Obfuscation means that which is cloudy, confusing or unintelligible.
You'll often hear some Forex teachers paraphrase this as "KISS" – 'keep it simple, stupid', or if they're being polite they may say 'keep it simple, sweetie'.
Why does this recommendation come up so often in trading, and does it really hold truth? We think so. In this lesson, we want to share two illustrations of this that we've encountered in our trading evolution, both of which really startled us. Our own trading has gotten simpler and simpler over time, and with that has come greater success.
We wanted to put this lesson early in the sequence of our Newsletters... (a) because it is so fascinating, and (b) because as we go along, we want to help you separate that which is important to learn to be a great trader from that which is superfluous and adds unnecessary complexity.
Lesson Two: Part One ~ Outsmarted by a Rat
In his book How We Decide, science author Jonah Lehrer sites an interesting experiment conducted at Yale University:
“A rat was put in a T-shaped maze with a few morsels of food placed on either the far right or left side of the enclosure. The placement of the food is randomly determined, but the dice is rigged: over the long run, the food was placed on the left side sixty per cent of the time. How did the rat respond? It quickly realized that the left side was more rewarding. As a result, it always went to the left, which resulted in a 60% success rate. The rat didn't strive for perfection. It didn't search for a Unified Theory of the T-shaped maze, or try to decipher the disorder. Instead, it accepted the inherent uncertainty of the reward and learned to settle for the best possible alternative.
The experiment was then repeated with Yale undergraduates. Unlike the rat, their swollen brains stubbornly searched for the elusive pattern that determined the placement of the reward. They made predictions and then tried to learn from their prediction errors. The problem was that there was nothing to predict: the randomness was real. Because the students refused to settle for a 60% success rate, they ended up with a 52% success rate. Although most of the students were convinced they were making progress towards identifying the underlying algorithm, they were actually being outsmarted by a rat.”
In other words, our human tendency towards adding complexity often yields worse results.
Lesson Two: Part Two ~ Evolution of a Trader
In his book Trend Trading, stock trader Darryl Guppy has created a great illustration of the evolution of a trader:
Knowledge is the x axis along the bottom. Success as a trader is the y axis on the left. Here's the story that this chart tells us: when you start trading you are in the bottom left corner of the chart. You don't know anything and need to learn a lot of basics – what a pip is, how to put on a trade, how to operate your trading platform, where to look to see if news is coming out soon, etc. Then you start studying some strategies and get some ideas about where to enter and exit. You start with these simple notions and may have a little success. Based on luck and that simple approach, many people can get to plateau 1 and can be a fairly average trader just with that.
But after some time, what happens? If you hit a little patch of bad luck, you start losing confidence and start searching for better ways to trade. This is normal. After all, in everything else in life, the more you learn, the better you do. This is shown by the red line in the chart labeled "Expected Development". The more you study, the more ways you have to approach something and you rise to the top.... right? Why should trading be any different?!
Well, surprisingly enough – it is different! As you proceed to acquire more knowledge of technical analysis, as your chart reading skills grow, as you study more books, take more courses, attend more webinars, acquire more techniques... instead of your success growing, it actually diminishes. You've added such complexity that you have become hampered by knowing too much. You're hit by paralysis-by-analysis . Your options are so plentiful now that it's hard to settle on any one of them when it's time to pull the trigger and make a trade. You may start using one indicator after another or one strategy after another, all in such rapid sequence that you have no idea how any one will work over the long haul. So it turns out that 95-98% of traders actually drop down to plateau 2, and the majority of those end up wiping out their accounts soon afterwards. They know more but they are less successful.
The minority (2-5%) are able to rise to the level of being a true Market Wizard. How? Look at the green line on the chart. It looks like it is going backwards to the left, away from the direction of getting more and more knowledge. These traders achieve this elite success level of being Market Wizards by cutting away much of what they have learned and seeking the most simple path they can find. It is the power of this reduction of knowledge - the simplification - that is so unexpected and so stunning!
What does this chart mean for you in your trading right now? Try stripping away components of what you are doing, and seeing how that works for you. Take everything off your charts that you don't absolutely need to see. Stop taking new classes for awhile now and instead take whatever you are doing and run it through extensive testing on the Forex Tester, and religiously put every trade into the Trade Log. Go deeper instead of spreading out wider. Look long and hard at whether you have something viable in hand before you jump to something new. You may find that your strategy ends up not being robust and that you will ultimately do better with a fresh approach, but if you avoid the temptation to add new things too often, you'll be doing yourself a great service.